2007 Annual Meeting ● Assemblée annuelle 2007

Vancouver

2007 Annual Meeting ● Assemblée annuelle 2007

Vancouver

Canadian Institute

of Actuaries

Canadian Institute

of Actuaries

L’Institut canadien desactuaires

L’Institut canadien desactuaires

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007 Modelling standards

Risk Assessment Models

• Will be released as a Research Paper this summer

• General guidance is applicable to all models, but focused is on risk assessment models

• Fairly comprehensive list of considerations

• Not yet a “how to” model primer• Expected to evolve as other Working Groups

develop methodologies

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Contents

• Model Design• Questions to consider early in the model building process

• Model Implementation• Assumptions, IT systems, data and processes

• Model Validation• Validation and calibration

• Governance• Internal models for capital purposes are only appropriate

when the risk management practices are adequate

• Reporting• Results must be reported in a manner appropriate for the

purpose and the intended stakeholder

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Capital Model Considerations

• Extreme scenarios• Measuring tail risk with a valuation model• may be like measuring time at the North• Pole with a sundial

• Aggregating stand-alone results• Must consider diversification, risk dependencies, risk

interactions and risk concentrations

• Practical implementation of framework• Nested stochastic framework requires approximations

• Need for “pervasive use”• Capital models should be actively and regularly used for

decision-making

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007 ALM / Market risk working group

Early modelling results

Summary• An overview of some examples based on

potential market risk “Advanced” methods• Very simple product – but some complex

messages• Scope - risks arising as a result of

companies’ investment and matching strategies:– Interest rates (risk free)– Equity markets– Real estate values– Foreign exchange rates– Inflation

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Potential ‘Advanced’ methodologies

• One year projection period– Real world terminal value at various CTE

levels– Risk neutral terminal value

• Run-off

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Product and investment strategies• Simple GIC – 1 benefit cashflow, 5 years

from now• ALM strategies

a) Matched - 5yr zero coupon bond

b) Short - 3yr zero coupon bond (On maturity of the bond, a 2yr bond will be purchased.)

c) Long - 7yr zero coupon bond. (After 5 years, the bond will be sold to provide the funds

needed to make the payment to the policyholder)

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Summary of cashflows

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Results* Capital is expressed as (TBSR – Best Estimated

Liability) / Best Estimated Liability

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One year real world (CTE0)

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One year real world method (CTE50)

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One year risk neutral method

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Interest rate distribution

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Interest rate distribution

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Run-Off method

Sensitivity tests

• Results were reproduced for the same product using the same ESG, but with different starting yield curves.

• Historical dates chosen were:– July 1989 – high interest rates and

inverted yield curve– May 1992 – steep upward sloping yield

curve

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Sensitivity tests

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1989 Results

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1992 Results

Conclusions• Complex dynamics – even for this simple

product and strategies• Products and strategies can drastically

affect ALM capital – modelled approaches can recognise this

• Choice of method can have a significant impact on capital - method and framework must be carefully evaluated and defined

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